The Future of Central Banking: Inflation Targeting versus Financial Stability
The global financial crisis has led to a profound rethinking of the consensus on monetary policy. Before the crisis, most monetary economists agreed that "flexible inflation targeting"—in which central banks focus on maintaining price stability and stabilizing the output gap—was an appropriate and sufficient mandate for conducting monetary policy. Key assumptions underlying the consensus were that this mandate would automatically lead to financial stability and that the framework of monetary policy could deal with cross-border capital flows.
But the consensus is increasingly seen as inadequate. Monetary economists and central banks have broadened their perspective on financial stability, viewing it as a major concern for the conduct of monetary policy. For example, many central banks are now publishing financial stability reports and other indicators that reflect the state of the financial system.
How much of the precrisis consensus remains valid and how much rethinking of monetary principles is needed? Are central banks right to broaden their goals to include not only inflation targeting but also financial stability? And should they be given an explicit mandate for financial stability, such as targeting the growth of credit and asset prices?
After the crisis, which tools are most appropriate for the conduct of monetary policy and should the goals of inflation targeting and financial stability be pursued using the same tools? If the two goals come into conflict, how should central banks resolve the conflict? And to what extent should central banks be involved in financial regulation?